Do gasoline prices “go up like a rocket and come down like a feather”? And if so, why? During the past 30 years countless congressional hearings and government reports, ranging from the Federal Trade Commission (FTC) to the U.S. Energy Information Administration (EIA), have examined and studied these two questions. The short answer is that there is some asymmetry between price increases and decreases, but it’s a stretch to say that prices shoot up like a rocket but fall like a feather.
Still, the perception remains. Three quarters of all consumers (75%) say that gas prices increase faster than they decrease, according to the 2017 NACS Consumer Fuels Survey.
Oil and gasoline are commodities and traded on various exchanges, which brings a great deal of transparency in looking at how they are both priced. There is also great transparency at the retail level. Retailers post their prices on the street, mostly on signs that drivers can see before deciding to pull into their lot. In addition, groups like AAA publish retail gas prices on a daily basis, while various gas price websites update prices even more frequently. While not perfect companions, this market transparency is helpful in examining the rate of retail gas price increases and decreases.
The link between oil prices and gas prices is most often used to draw the rocket/feather conclusion. Although retail prices are greatly affected by oil prices, linking the two to validate the rocket/feather theory doesn’t necessarily work.
When oil prices increase, there is often a delay before that price increase is seen at the corner store. The delay from an initial oil price increase happens for two reasons:
- There is another price between the crude oil price and the retail gas price: The wholesale gas price—not the crude oil price—is what the retailer must pay for fuel that can then be sold to the consumer, and this price often adjusts independent of crude oil prices.
- There is a lag between when wholesale gas prices increase and when retail gas prices increase. This is because retailers usually hold back prices increases to attract price-competitive customers.
It’s also worth noting that most people don’t notice that retail prices often remain unchanged during the first few days of an oil price increase. It’s not until retail prices move that consumers become especially attuned to price increases. After that point, if oil prices and retail gas prices both increase, most consumers assume that the relationship between the two is immediate.
Naturally, when oil prices begin to decline from a peak, many consumers expect retail gas prices to immediately follow suit. But the lag continues, and it can take a few days for any price decreases to be felt at the retail level.
There are times when retail prices and wholesale prices change at different rates — but is this the rocket/feather phenomenon? Probably not.
A September 2012 Federal Trade Commission report, “Asymmetric Pass-Through in U.S. Gasoline Prices,” found that “price asymmetry persists for approximately 10 days until the paths are no longer distinguishable.” So what is happening that creates price declines that are somewhat slower than price increases? It comes down to consumer price sensitivity and market uncertainty.
Consumers are more price sensitive to gasoline than any other product. NACS consumer research conducted since 2007 has consistently shown that approximately two-thirds of all gas consumers would drive five minutes out of their way to save five cents per gallon. In January 2018, with gas prices at $2.49 per gallon, 63% of consumers said that they would drive five minutes out of their way to save five cents.
When wholesale prices increase as little as a few cents per gallon, retailers know that they can’t pass along the full price increase because they don’t know if the competition is incurring the same increase in costs, let alone whether they will pass these costs along through higher retail prices. In addition, there can be great variations in wholesale prices in a given market, depending on whether the station is branded or unbranded, the site’s sales volume, the company’s business strategy or even the time when its latest wholesale price was locked in. On days of extreme price volatility, wholesale gas prices can rise or fall in some markets by 20 cents per gallon—or more. This level of extreme price volatility is seldom seen at the pump because most retailers cut margin to fight for price-sensitive customers.
Over the past five years (2013 to 2017), retailer gross margins (before expenses) have averaged 21.7 cents per gallon (7.8%). Expenses to sell that fuel range from about 12 to 16 cents per gallon, so any change in the gross margin has a significant effect on profit margins.
During times of rapidly escalating wholesale prices, retailers hold back the full price increase. Essentially, everybody plays a game of chicken to see who will blink first and raise their prices to pass along the increased wholesale costs. Because the first retailer in a market to fully adjust prices higher can potentially lose customers, most retailers instead cut margin and absorb some of the price increase.
And that’s exactly what happened over the first few months in 2013. The February 7, 2013, “OPIS Retail Fuel Watch,” which tracks prices and retail margins in more than 300 markets across the nation, reported that rack-to-retail gross operating margins were at their lowest level in five years. “National operating margins tumbled to 8.4 cents per gallons, a level unmatched in five years. When you factor out credit card processing fees, many retailers are pumping gasoline at a loss,” the weekly publication noted.
However, when wholesale prices go down, retailers extend their margins to recoup what they lost when wholesale prices increased. Crude oil prices and wholesale gas prices may fall, but this decrease may not be fully reflected at the retail level. Consumer price sensitivity also plays a role. NACS consumer survey results suggest that when gas prices are rising, consumers search for a better deal. However, immediately after prices go down, consumers may stop searching for the lowest price on the street. This gives a cushion for retailers to lower prices in smaller increments and recapture lost margin.
Consumer price sensitivity clearly plays a major role in the relationship between wholesale and retail price increases, and market uncertainty is a significant influence when wholesale prices decline. On any given day, retailers don’t know where wholesale prices could be heading, so they tend to try to recapture lost margin as quickly as possible—before prices rise and margins tighten. This means that retailers may pass along a smaller percentage of the wholesale price decrease.
Not only are retailers uncertain about the future of wholesale prices, they don’t know how the competition will react. If any competitor “dives to the bottom” and quickly drops prices in an attempt to capture more price-sensitive consumers, retailers must quickly follow suit or risk losing their market position. If they want to maintain consumer traffic, retailers must keep one eye on costs and margins and the other on the competition—because either one could change at a moment’s notice.
In 2008, both margin extremes were demonstrated. The July 7, 2008, “OPIS Retail Fuel Report” noted that the end of June 2008 was the “end to a miserable quarter which saw gross rack-to-retail margins average just 10.3 cents per gallon. Only two other quarters in the past six years saw lower profits… Most analysts are not optimistic about a crash in wholesale prices anytime soon.”
But as we know now, wholesale prices did crash in the second half of 2008. While retail prices marched $1.10 upward over the first seven months of the year (January to July) and appeared poised to continue that climb, they instead dramatically declined and the last five months (August to December) saw retail prices drop $2.50 a gallon.
“The year started off dismally however and looked like it would end with many chains going under,” according to the OPIS report. “Some analysts were predicting $200 barrel crude and $5.00 per gallon retail prices but most felt that petroleum markets were overvalued and due for a correction. Few however could predict how fast and how far they would fall.”
Even though the second half of 2008 delivered extraordinary margins, the abysmal first half and uncertainty over future prospects caused many fuels retailers to close. As a result, for only the third time in the past 15 years, the number of convenience stores selling gasoline decreased in 2008.
While there may be asymmetry between gas price increases and decreases, it really isn’t at the rocket and feather level.
The Federal Trade Commission’s “Asymmetric Pass-Through in U.S. Gasoline Prices” report noted that since 2006, the overall impact of price pass-through asymmetry was about 1 cent per gallon for unbranded retailers and 2 to 3 cents per gallon for branded retailers. These findings were consistent with those from a number of different government studies conducted over the years.
The U.S. Energy Information Administration’s February 1999 report, “Price Changes in the Gasoline Market,” noted that retail prices “do sometimes increase faster than they fall, but this is largely a lagged response to an upward shock in the underlying wholesale gasoline or crude oil prices, followed by a return toward the previous baseline. After consistent time lags are factored out, most apparent asymmetry disappears.”
So what would happen if retailers were mandated to have symmetrical price pass-through?
According to FTC, this would actually hurt consumers. Its 2012 report noted that if price pass-through were symmetric, retail margins would likely be around 2.27 cents per gallon lower. Given that retail profit margins per gallon at that time averaged 1 to 5 cents per gallon, with all other factors equal, FTC concluded that these reduced margins “may cause firms to exit.” And because competition puts significant downward pressure on prices, any reduction in competition would lessen that downward pressure and could ultimately hurt consumers.
Gas is unique among a convenience retailer’s products. While other products are affected by the prices of commodities—orange juice, bread or hamburger patties—gas is a commodity and its price can see dramatic changes—changes that happen over a period of days or even hours. At the same time, consumers are extremely price sensitive and will seek out deals or drive out of their way to save as much as a few cents per gallon at the pump.
These dynamics affect every decision made by fuels retailers as they seek to attract consumers to their pumps and inside their stores, whether wholesale prices are increasing or decreasing.